Photo = Getty Images Bank.
It has been officially announced that the US central bank (Federal Reserve) is discussing normalizing monetary policy. In order to respond to the economic downturn caused by the spread of the novel coronavirus infection (COVID-19), the US Federal Reserve is reducing the amount of money supplied to the market.
Currently, the Fed is buying 120 billion dollars worth of U.S. Treasuries ($80 billion) and mortgage-backed securities (MBS) from the financial markets every month. When the central bank gives cash (dollars) to financial companies and receives government bonds and MBS, the market evaluates them as ‘the Fed prints dollars and supplies them to the market’. The official name is ‘Asset Purchase Program (Quantitative Easing)’.
It’s already starting to get difficult. First, consider quantitative easing only to the extent that the Fed provides liquidity (money) to the market.
Quantitative easing, a key driving force in recovering from the COVID-19 economic recession In March of last year, the global economy came to a sudden halt due to the spread of the novel coronavirus infection (COVID-19). Lockdown measures are in place to prevent the movement of people to prevent the spread of the infectious disease.
Even if you are just breathing at home, there are money that you have to spend like monthly rent and food. Firms also incur fixed costs such as rent, labor, and interest costs. It would be nice to have a lot of money in stock, but such people and companies are rare. Even if you go to a bank to borrow more money, commercial banks do not easily provide additional loans amid fears that the world might end due to an epidemic. If the loan goes badly, the bank can go bankrupt.
Quantitative easing is about resolving the anxiety of commercial banks and creating an environment where they can smoothly borrow money. The central bank will provide enough cash, so don’t panic and lend money to economic agents.
There was an effect. In March of last year, companies that looked like they were going to go bankrupt survived, and this year, the economy recovered so rapidly that it is faster to count the companies that did not make a surprise (earnings surprise). The size of the US Federal Reserve’s assets and the trend of the S&P 500. The increase in the size of the Fed’s assets means that the market has been supplying money and receiving bonds (assets). /Source = NH Investment & Securities
This change can also be seen in stock indices. This year, the Dow Jones Industrial Average of the United States has broken the all-time high of nearly 50 times based on closing prices. The current all-time high is 35231.87 on the 16th. Compared to the low of 18591.93 on March 23 last year, when the world seemed to end due to the spread of Corona 19, it is a level that has risen by 89.50% in one year and five months. Korea’s KOSPI has more than doubled from its low in March last year.
In response, both inside and outside the Fed started talking about tapering the size of the asset purchase program in the first half of this year. At first, however, it was not officially discussed in the Federal Open Market Committee (FOMC), which decides monetary policy in the United States. Some austerity (hawkish) Fed members were just about to put some tension in the market by stating that tapering was necessary. Tapering was first mentioned at the FOMC in June, a rather punitive comment that “we talked about discussing tapering”. Fearing that the market would be shocked if they refused to pay the money, the Fed also handled the issue of tapering as carefully as possible.
The minutes of the July FOMC meeting in the US, finally released on the 18th (local time), contain the content that most of the attendees decided that “it may be appropriate to start slowing down the pace of asset purchases this year.”
Naturally, the market flinched. In the two days from the day the FOMC minutes were released in July, the Dow Jones Industrial Average fell 1.27%, the S&P 500 index fell 0.95%, and the Nasdaq index, which focuses on technology stocks, fell 0.78%, respectively. . Still, it rebounded on Friday, the 20th, and the Nasdaq recovered above the closing price on the 17th before the July FOMC minutes were released.
On the contrary, the Korean stock market reacted violently. On the 19th and 20th (Korean time), the KOSPI fell 3.12%, breaking the 3100 line. The KOSDAQ also plummeted 5.21%, breaking the 1,000 line. The Korean stock market also attempted a rebound at the beginning of the market on the 20th, but was shocked once more by the news that the People’s Bank of China, which was expected to introduce an accommodative monetary policy, has frozen the loan preferential rate (LPR), which is the base rate.
The central bank’s direct intervention in the real economy… Currency Corruption You may be wondering if the stock price should be tapered right away. If quantitative easing continues, there is also the expectation that the stock market will continue its all-time high. Why tapering? Learn more about quantitative easing.
A phrase that appears frequently when describing tapering is ‘monetary policy normalization’. Quantitative easing now means ‘abnormal’.
Earlier, I described quantitative easing as “the act of buying government bonds by the central bank”. The act of buying government bonds itself is not abnormal. The base rate, which is the most basic indicator for those who have seen the economy, is realized through the central bank’s purchase of government bonds.
The US Federal Reserve determines and announces the base rate through the FOMC and the Bank of Korea through the Monetary Policy Committee. The announcement at this time is just a kind of ‘declaration’ that the price (interest rate) in the government bond circulation market will be tied to the determined base rate level. Afterwards, the central bank induces a fall in interest rates (increasing the price of government bonds) by purchasing government bonds when the interest rate of government bonds traded in the market is higher than the base rate, and selling government bonds when the interest rate is lower than the base rate, inducing an increase in interest rates (decreasing the price of government bonds). Keeping the declaration.
There is a saying “Don’t fight the Fed”. The central bank’s power in the bond market is so powerful. Because the power of central banks is so strong, when the gap between the price of government bonds (interest rates) and the base rate in the market widens, market participants move ahead to bring the two rates to a similar level. The Federal Reserve Headquarters in Washington, DC. /Photo = AFP, Yonhap News
In this case, people are likely to complain, “What is abnormal about quantitative easing?” The difference between government bonds, which is the target of quantitative easing, and government bonds, which is the target of the base rate, is confusion because the words ‘long-term’ and ‘short-term’ are omitted.
The target interest rate is short-term government bonds. In other words, the central bank has intervened in short-term interest rates. Short-term interest rates are used for transactions between financial institutions. In the absence of an economic crisis, even if the central bank lowers the short-term interest rates used by banks to transact with each other, commercial banks feel comfortable. Naturally, the loan review process becomes less stringent, and the interest rate for long-term loans to businesses and households will also come down. When a company invests money borrowed from a bank, the economy will be revitalized.
On the other hand, when a crisis occurs, no matter how much the central bank lowers the short-term interest rate (base rate), commercial banks, feeling anxious, do not increase lending. ‘Cause I’m afraid I’ll ruin it Those who absolutely need to borrow money will be ejaculated by saying, “I will raise the interest rate higher, so please lend me some money.” Long-term interest rates will rise.
The role of a bank is to make money flow smoothly throughout the economy, but if you don’t play that role and just hold on to the money to live alone, it will adversely affect the economy. The most dramatic example of this is the 2008 global financial crisis.
The global financial crisis was, as the name suggests, a ‘crisis of commercial banks’. Commercial banks are in crisis because they mishandled derivatives related to real estate loans. In fact, Bear Stearns, one of the five largest investment banks on Wall Street at the time, and Lehman Brothers, the world’s fourth-largest investment bank, went bankrupt. Other commercial banks who saw this would have thought, ‘Even a big bank like that goes bankrupt, and you have to secure cash to survive.’ As a result, even companies that are in good standing do not extend their loans and try to collect them. Even companies that have worked hard without paying any interest are pushed into bankruptcy. The crisis created by finance has been transferred to the real economy.
Quantitative easing is a monetary policy in which the central bank buys long-term government bonds and raises prices to press long-term interest rates, while helping commercial banks to supply money smoothly.
However, the problem with quantitative easing is that the central bank intervenes more directly in the real economy than when it adjusts the base rate. The sarcasm of “the Fed prints dollars and supplies them to the market” is not unheard of for nothing.
When the state (central bank) prints money excessively and the value of money falls, it is said that ‘currency is corrupted’. Currency has value based on the trust of the country, but if the country prints money at random, people’s trust that the value of money will be maintained will inevitably weaken.
It may not be a coincidence that Bitcoin was invented in 2009, when the Fed first implemented quantitative easing. “It’s not the first time” tapering Fed financial companies that create buffers ahead of time focus more on profits than on the national economy. It would be good for the central bank to continue supplying cash so that quantitative easing, which can comfortably generate profits, continues. So when tapering is mentioned, the stock market fluctuates.
Let’s look at the time of the global financial crisis, which was also the first case of quantitative easing. The then-Fed Chairman Ben Bernanke abruptly mentioned the word ‘tapering’ during a hearing in the US Senate on May 22, 2013, and more than a month later, at the FOMC in June of the same year, the possibility of tapering was formalized. Former Fed Chairman Ben Bernanke. /Photo = Hankyung DB
With this as an opportunity, the global stock market exhibits symptoms of a ‘tightening attack (tapering tantrum)’. During the four trading days from June 19, 2013, when the FOMC ended, the US Dow and Nasdaq fell 4.30% and 4.64%, respectively. The KOSPI, which was affected by this, also fell by 5.70% from June 20 to 25, 2013 (Korean time). It was not that the scale of quantitative easing would be reduced immediately, but it was the result of an announcement that it could be implemented six months later. The financial investment industry called this the ‘Bernanke shock’.
This time the market shock seems to be less than it was in 2013. This appears to be due to the fact that the Fed did not abruptly declare a taper but consistently warned the market of possible tightening.
In addition, we have prepared a buffer plate in case the bank becomes difficult due to tapering. After the FOMC ended on the 29th of last month, the Fed announced plans to introduce a ‘Standing Repo (SRF)’. A standing repo is a permanent repo (repo) operating organization, where banks can borrow money by entrusting them with government bonds and government bonds as collateral. The tapering will reduce the amount of long-term Treasury purchases, but if the bank’s liquidity problems arise, it will lend money using Treasury bonds sold to the Fed as collateral.
Growing U.S…. The problem comes from the ‘weak loop’, perhaps more worrisome after the tapering has been implemented. First of all, the US stock market doesn’t seem to have much to worry about. This is because the shock immediately after the start of the tapering on January 29, 2014 was the last turbulence the New York Stock Exchange experienced due to the tapering. Since the Fed began tapering, it has further reduced its asset purchases each time the FOMC is held, but year-over-year in 2014, the Dow and Nasdaq rose 7.52% and 13.40%, respectively.
Since then, the U.S. stock market has been in a long-term rally for nearly 10 years, although it has been volatile in the aftermath of the Chinese debt crisis of 2015-2016 and the U.S.-China trade dispute in 2018-2019. American companies led the 4th industrial revolution, which was accelerated by the advent of smartphones in the late 2000s, and this is the result of unparalleled growth of the US economy.
The problem was the countries with poor economic health. In 2011, near the end of the second quantitative easing to overcome the global financial crisis, the European fiscal crisis occurred due to the government debts of Portugal, Italy, Ireland, Greece and Spain (PIIGS). Countries with weak manufacturing bases were reaching their limit while making a living with debt. The European financial crisis led to the third quantitative easing in the US. After that, as mentioned above, China was pushed into a gloomy state in 2015-2016 as it could not afford the debt it had built up excessively to maintain its rapid growth.
Compared to this, Korea was on the better side, but it was also not satisfactory. The KOSPI was locked in a box of 1800-2200 from the beginning of the Fed’s tapering in 2014 to the first quarter of 2017. In 2017-2018, it crossed the 2600 level thanks to the semiconductor super cycle, but the 1900 line collapsed in the aftermath of the trade dispute between the US and China. Since then, the peak just before the outbreak of the COVID-19 outbreak is 2267.25 on January 22, last year.
It is unknown how South Korea will be affected as it collects the money the US Fed has loosened to overcome the COVID-19 pandemic. Compared to 2014, the pessimism that Korean households are carrying more debt and the optimism that there are many Korean companies making strides in the future growth industry are confronting each other.
Korea has many experiences in turning crises into opportunities, such as the boom from the financial crisis to the mid-2000s, and the Chahwa refinery (automotive/chemical/oil refining) rally after the global financial crisis. Korea has emerged as a global pharmaceutical production base despite the spread of COVID-19, and the competitiveness of the battery industry is being recognized amid the blooming electric vehicle market. It remains to be seen whether it can be repeated this time as well.
By Han Kyung-woo, reporter at Hankyung.com case@hankyung.com
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